Vertical limit | 10 years on, the first cracks appear

Year 2001. Taiwanese OEM production hummed along, retail prices were buoyant, and cycling was enjoying an upswing in popularity across the Asia-Pacific region. However, as the new millennium’s first decade matured, so too did a trio of inter-related trends that would upset the bicycle industry’s delicate ecosystem and threaten to explode into a full-blown zero-sum contagion.

Ask any bicycle retailer today what their major concerns are and you’ll likely get the same answer: low margins, online sales, too much competition. A decade earlier, these factors either did not exist (online sales) or were stymied by the conventional supply chain described in the previous ‘Vertical limit’ articles. But not all industry players were satisfied with the status quo.

TREND ONE – COMPETITIVE BARRIERS REMOVED
Original Brand Manufacturers (OBM’s) like Giant Bicycles had by now gained significant traction across retail outlets in the Asia-Pacific region, particularly in Japan, Singapore, Australia, New Zealand. Giant’s pricing was particularly aggressive, but the brand offered more than just a price proposition. The link-up with the powerful ONCE professional cycling team and top athletes across cycling disciplines was a terrific image device. The company’s Mike Burrows-designed “compact road” road bikes were also considered highly innovative and desirable.

Ultimately though, it was Giant’s pricing that hooked consumers. It seemed every subsequent year brought with it better specification and lower pricing. Nobody seemed to question whether this was sustainable, especially not Giant retailers who thrived on delivering category-killer product to market. Initially, these retailers enjoyed a defined region within which no other Giant dealer could operate. This reduced intra-brand competition, thus preserving retail margins.

But Giant needed more sales to grow market share and pay for “satellite” infrastructure. With many Giant retailers already at capacity or unable/unprepared to expand, more stores were needed. This resulted in Giant reneging on promises of exclusive selling territories and beginning the slow destruction of the protected retail foundations at the far-end of the bicycle industry’s long supply chain.

[As at November 2011, Giant Australia lists 214 retailers on its website; approximately one point of sale for every 100,000 people in Australia].

TREND TWO – ONLINE SALESPersonally, I remember 2001 very well for other reasons. It was the year I “discovered” Cambria Bicycle Outfitter, a US-based bicycle retailer that had recently opened a web-store for international orders. At a glance, Cambria’s product mix and pricing (even with the robust US dollar at the time) outshone Australasia’s in every segment. How was this possible?

A screenshot of Cambria Bicycle Outfitter’s home page from 2001

First, we need to understand there are two main categories of bicycle products: Original Equipment (OE) and After Market (AM).

With every new model year, bicycle brands submit orders to bicycle parts manufacturers so they can build frames into complete bicycles. These parts – wheels, groupsets, handlebars, forks, etc – would be delivered in bulk cartons, without the consumer packaging we see in bike shops. These are referred to as Original Equipment (OE) parts.

Most of the time (unless a bicycle parts manufacturer customises an item specifically for a bicycle brand client) the very same parts can be purchased by that manufacturer’s importer/distributor – but with consumer packaging. These are referred to as After Market (AM) parts.

Generally speaking, a bicycle brand buys more volume than a distributor, so the pricing for OE parts is lower. Remember, they also don’t pay for unnecessary packaging.

An example of this is a bicycle chain. SRAM, for example, packages individual After Market chains into plastic snap-fit containers which can be merchandised in several attractive ways. If Felt Bicycles were to buy 50,000 of the same chain for several road bike models, they get batches of hundreds or chains in cardboard cartons; not glamorous, but practical for shipping and quick assembly – at a fraction of the retail price.

On some occasions, the bicycle brand – already well into production and with bikes in the market – realises it has overestimated annual demand and halts frame production. This could be due to complete incompetence by the brand’s management (forecasting) or genuine unforseen disruptions. Consequently, this leads to a lot of “orphan” OE parts that, due to their model-year-specific lifecycle cannot be used for the following year’s production. The most expeditious method is to funnel the parts in a single batch, or dump in manufacturing parlance, to a third-party company with re-selling capabilities.

Most often, these parts are held in tariff-neutral bonded warehouses across Taiwan’s ‘Special Economic Zones’; meaning they arrive in Taiwan as parts, before being bolted to a frame and exported as a complete bicycle. If they were dumped locally (in Taiwan), import documentation and duties would be applied. Depending on the clearance price, this still allowed Taiwanese bicycle retailers with sufficient capital to buy bulk OEM product and still undercut a distributor’s import pricing. However, due to zero import duties, market size and proximity, the most common destinations for these OE parts were Hong Kong and Singapore-based “distributors”. From here, they could be easily and profitably disseminated to willing buyers.

One major problem with offloading large quantities of some OE parts – especially high-end products like road wheels, suspension forks, etc – into Asia was the comparatively undeveloped bicycle market and low per-capita income of its citizenry. Given the manufacturer of those OE parts couldn’t, or wouldn’t, help with the surplus this also ruled out the possibility of approaching downstream customers in the After Market supply chain.

Enter Cambria Bicycle Outfitters (CBO) and the first generation of “global bicycle retailers”. Having been a successful national mail-order business since 1986, the US-based CBO started to move beyond domestic borders in the late 1990’s. With the world as its marketplace, and with a short supply chain (direct to consumer) CBO had unrivalled scope to resolve a bicycle manufacturer’s excess inventory problems. From the late 1990’s, US-based online bicycle retailers would enjoy years of dominance as they waited for other countries to play e-commerce catch-up.

TREND THREE – GRAY MARKETWhile Giant’s yearly spec-up, cost-down, approach to complete bicycles was already compressing supply chain margins of less-vertical bicycle brands striving to compete on price, the online marketplace was informing consumers how much that built bike should be worth. Bicycle enthusiasts were now able to see cheap (excess OE) inventory listed online – and started to question the ticket price of everything. But other practices, not readily understood by consumers, were pushing the price expectations even further down.

Back in Taiwan, the surplus OE quantities were becoming more deliberate as new sales channels developed. Whilst co-ordinating delivery of parts for their OEM clients, some Taiwanese agents identified opportunities to diversify into more profitable services. It was not uncommon for agents to inflate a client’s OE order, with the delivered surplus being sold directly by the agent to local retail shops or even individual customers. This lucrative “gray market” had been going on for years, but Australasia had been sheltered due to distance, tight import controls and small market size (less easy to sell large OE volumes inconspicuously).

Yet, savvy importers across Asia had known a loophole for years which finally caught on further south – we’ll look at the role Original Design Manufacturers have played in today’s deflated bicycle market in the next instalment of ‘Vertical limit’.

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2 thoughts on “Vertical limit | 10 years on, the first cracks appear”

Looking forward to the next installment. I have been arguing for a while that it is not only a case of overpriced (‘greedy’) wholesalers rather it goes much higher up. Does this mean that the brands are hurting local distributers and retailers.. or should be held accountable? At Eurobike I was chatting on one brand who were on the ball and specifically tracking distribution and serial numbers to isolate black sheep distributers using loopholes to undermine RRPs. For another big brand, the international sales manager was completely oblivious – one of those brands where consumers can enjoy 65% + savings by purchasing overseas online.

Thanks for your input, Christopher. Brands were certainly not hurting distributors for many, many years – quite the opposite – but cosy relationships are no longer enough to satisfy market share appetite. Going into more detail on that in part 5.